Monday 8 September 2008 19.01 EDT
First published on Monday 8 September 2008 19.01 EDT

Stock markets were in jubilant mood yesterday after the US treasury announced it was putting the two big beasts of the American mortgage market into "conservatorship". Don't be misled by this ugly piece of economics jargon: it's just another way of saying nationalisation - and it was somewhat bizarre to find the equity markets of Tokyo, London and New York, where dealers profess to exalt the free market, whooping for joy at the state taking a grip.

The reason for the rise in share prices was pure relief. Just as they were at the time of the run on Northern Rock a year ago this week, just as they were when Bear Stearns went under in March - and just as they were at the end of last week - stock markets have been in a complete funk at the mounting losses from the credit crisis. Hank Paulson, secretary of the US treasury, did not take Fannie May and Freddie Mac into public ownership because he has become a born-again socialist: he acted because he feared a systemic global financial crisis that would prompt the biggest depression since the 1930s.

There are five points to note. The first is the sheer scale of the action. Fannie and Freddie together underwrite half the home loans in the world's biggest economy, and the sum involved is of the order of £3 trillion - about double the entire annual output of the British economy. This is the biggest rescue operation since the credit crunch began - but it probably won't be the last.

The second point is the duration of the crisis. When markets seized up in August 2007, few market practitioners would have anticipated that central banks and finance ministries around the world would still be firefighting 13 months later. Central banks have cut interest rates; they have pumped money into the banking system; they have agreed to swap worthless mortgage-backed securities for rock-solid government bonds; they have taken failing banks into public ownership. Each time, the markets have rallied in the hope that the latest crisis will prove to be a catharsis - and each time they have been proved wrong. Some analysts do not buy the argument that Paulson's rescue marks the beginning of the end for the credit crunch; some say it was an act of desperation necessitated by the horrendous state of the global financial system.

Whatever the motivation, the third point to make is that the government-backed rescue of Fannie and Freddie was right. The length and depth of the credit crunch has validated the views of the International Monetary Fund, George Soros and Alistair Darling that this is the most serious financial crisis the global economy has faced since the 30s. Fannie Mae was set up in that decade as part of the New Deal reforms to help the US economy recover from the depression. With almost perfect symmetry, the decision to take it into public ownership highlights the bankruptcy of the freewheeling model that replaced the much more heavily regulated financial system of the decades after the second world war. Let's be clear: the world is in the mess it is today not because state regulation of the banks was too stringent, but because the state was too timid in the face of demands for deregulation, liberalisation and privatisation. The upshot was excessive speculation, and economies in which the financial sector wields far too much influence and reward structures invite foolishness.

As such, the question is what happens now. The fourth conclusion to be drawn is that the free market has no answers to the problem other than to let banks go to the wall. But no policymaker, even those with the most impeccable laissez-faire background, is prepared to let Bear Stearns, Northern Rock or Freddie and Fannie go bust. Some smaller institutions may be allowed to go to the wall, if only to show the US treasury is aware that the bailouts are being financed by taxpayers, but the global financial community now has institutions that are simply too big to fail.

But if the big financial institutions cannot - unlike, say, a car company or an airline - be allowed to founder, they also cannot be allowed to conduct themselves in the same way as companies where there really is a risk of failure. Congress will undoubtedly demand tougher regulations for the activities of US banks in exchange for bailing them out, and rightly so. If ever there was a time to bring in controls on the ability of banks to create unlimited amounts of credit, to restrict the more toxic forms of derivatives, to rein in the activities of hedge funds, to insist that remuneration structures are not biased in favour of reckless speculation, and to use anti-trust law to break up the power of the big institutions then this, surely, is it.

This leads on to the final point. The credit crunch should be a crisis for parties of the right. They were, after all, behind the campaign to demolish controls on financial markets in the final quarter of the 2oth century. Yet there is scant evidence that either the Republicans in the US or the Tories in Britain will pay a price for the policy errors of the past. In part, that is because in the US the whiff of a return to the soup-kitchen days of the depression brings out the interventionist streak in any administration. In part, though, it is because neither Barack Obama nor Gordon Brown seem willing to seize the social democratic moment. That's dumb politics. It means that what should be a crisis for the right has become a crisis for the left.